Outlook for the Post-Iran Sanctions Oil Market

Still feeling optimistic about the near-term future of oil? Here’s something to think about:

When Iran, Iraq and Libya return to their full production potential, the world price of crude oil could fall considerably lower.

Right now most eyes are on Iran.

With a plan in place to phase out international economic and export sanctions against the country, Iranian officials have vowed to raise oil production by at least one million barrels per day (b/d).

Some industry experts think Iran could lift its total oil production to more than five million b/d, up from last year’s annual level of over 3.3 million b/d of crude plus liquids.

Will Iran be able to bring substantially higher oil exports to market?

This outlook includes arguments for and against a surge in Iranian production and a resulting drop in world oil prices.

FOR: Geology

Iran’s proved oil reserves of 150 billion to 160 billion barrels is almost 10 percent of the world’s total, ranking it fourth in world crude reserves.

Thick deposits on the floor of the ancient ocean Tethys eventually became the world’s biggest oil and gas accumulations around the Middle East Gulf. The collision of the Arabian Plate with the central Iranian plateau led to the Zagros Orogeny and created an extensive folded zone.

Those folded structures present excellent traps for oil and gas, and now contain Iran’s major oil and gas fields.

“Global Resource Assessments from Total Petroleum Systems” (AAPG Memoir 86, 2005) makes it clear just what a monster the Zagros Fold Belt Province is, in the Zagros-Mesopotamian Cretaceous-Tertiary total petroleum system.

Still feeling optimistic about the near-term future of oil? Here’s something to think about:

When Iran, Iraq and Libya return to their full production potential, the world price of crude oil could fall considerably lower.

Right now most eyes are on Iran.

With a plan in place to phase out international economic and export sanctions against the country, Iranian officials have vowed to raise oil production by at least one million barrels per day (b/d).

Some industry experts think Iran could lift its total oil production to more than five million b/d, up from last year’s annual level of over 3.3 million b/d of crude plus liquids.

Will Iran be able to bring substantially higher oil exports to market?

This outlook includes arguments for and against a surge in Iranian production and a resulting drop in world oil prices.

FOR: Geology

Iran’s proved oil reserves of 150 billion to 160 billion barrels is almost 10 percent of the world’s total, ranking it fourth in world crude reserves.

Thick deposits on the floor of the ancient ocean Tethys eventually became the world’s biggest oil and gas accumulations around the Middle East Gulf. The collision of the Arabian Plate with the central Iranian plateau led to the Zagros Orogeny and created an extensive folded zone.

Those folded structures present excellent traps for oil and gas, and now contain Iran’s major oil and gas fields.

“Global Resource Assessments from Total Petroleum Systems” (AAPG Memoir 86, 2005) makes it clear just what a monster the Zagros Fold Belt Province is, in the Zagros-Mesopotamian Cretaceous-Tertiary total petroleum system.

That system ranked first in the world in:

Total estimated oil endowment, with more than 466.7 billion barrels.

Future oil production – 366.3 billion barrels.

Mean estimated undiscovered oil – 94.5 billion barrels.

Iran has favorable geology, and a lot of oil.

AGAINST: Capital

Most industry experts agree that it will take at least $30 billion in capital infusion to kick-start Iran’s productive capacity.

Iraq faced a similar challenge in rebuilding its oil infrastructure and was able to attract financing and industry participation, but that was at a time of much higher world oil prices and more readily available funding.

How much capital will be available to Iran, and under what terms, remains to be seen.

Leonardo Maugeri, former head of strategy at Eni SpA, is now an associate at Harvard University’s Kennedy School in Cambridge, Mass.

Maugeri said in order to exploit its full potential to 2020-22, Iran needs investment of at least $70 billion. But a quick initial boost to production from current levels might not be so expensive, he added.

“Iran may raise its oil production – crude oil and condensate – by around 900,000 barrels per day in just one year, because most of this production capacity was cut off by the most recent sanctions.

“That production increase is not as expensive as many think,” Maugeri said. “It only implies spending a few billion dollars.”

FOR: Oil in Storage

Iran is believed to be storing up to 40 million barrels of oil, mostly in floating storage on tankers.

When sanctions and export restrictions are lifted, Iran could not only begin marketing more of its excess production but also sell its stored stocks of crude, giving it a quick boost in income.

Edward Morse, global head of commodities research for Citigroup, said Iran’s stored crude and condensate could be high in sulfur, and only about one-third of it will create overhang in oil markets.

If the oil is sour it might sell at a steep discount to today’s prices.

AGAINST: Political Uncertainty

The world’s geopolitical situation has not favored Iran.

Even if it gets a best-case nuclear limitation deal, Iran must meet a number of conditions to escape sanctions. And any meaningful violation could bring about a full reinstatement of sanctions under existing agreement terms.

While a great deal has been written about Iranian-Israeli tensions, Tehran is almost 1,000 miles from Jerusalem. Iran is bordered immediately on the east by Afghanistan and on the west by Iraq, and it is within reach of Islamic State turmoil.

Middle East tensions and an unclear path on sanctions may make it difficult for Iran to attract industry participation and to enter into reliable long-term supply arrangements.

FOR: Asset Access

Economic restrictions and sanctions have cut Iran off from billions of dollars in overseas capital reserves and assets.

Banking compliance with U.S. sanctions has restricted Iran’s access to foreign reserves, and many of its overseas assets remain frozen and inaccessible.

The amount of restricted accounts and other assets is disputed. Iran has claimed it will regain access to $30 billion of “usable assets” when sanctions are lifted. Other estimates put Iran’s restricted assets at $100 billion or more.

Whatever the final amount, access to previously restricted assets will benefit Iran. The biggest obstacle might be the United States, which fears Iran will use some of the money to fund militant groups.

AGAINST: Production Declines

While Iranian production has been slowed, but not stopped, there’s no certainty about the future productive capacity of its fields.

Half of Iran’s production comes from oil fields that are more than 70 years old, including Ahwaz-Asmari, Marun and Gachsaran, according to the International Energy Agency.

Almost 80 percent of Iran’s existing reserves were discovered before 1965. The U.S. Energy Information Administration estimates that Iranian oil fields have natural decline rates of 8-11 percent.

In much of 1976-77, Iran produced more than six million b/d. Production fell after the 1979 Iranian Revolution, but Iran eventually managed to increase production from two million b/d in 1986 to 4.2 million b/d in 2008.

Then lower oil prices, recession and sanctions cut production again. Following the implementation of new sanctions in 2011-12, Iranian oil production fell from almost 3.7 million b/d in 2011 to 2.7 million b/d in 2013.

According to data from Bloomberg, Iran’s recent production has been about 2.8 million b/d. How much Iran can increase production, and how quickly, and how long it can sustain increased production, remain serious questions.

FOR: Redevelopment

Maugeri believes Iran could increase production to more than five million b/d in the next five to seven years.

“In the medium term, to 2020-22, Iran may produce more than five million b/d, and even reach 5.3-5.4 million b/d, either by developing newly discovered fields or by redeveloping existing fields by raising their current, and modest, recovery ratio,” he said.

Iranian officials claim a recovery ratio around 25 percent, compared to a world average of 35 percent, but the reality is that Iran’s recovery ratio is no higher than 19 percent, Maugeri said.

AGAINST: The USA

Proposals to initiate a nuclear-industry monitoring program and to lift sanctions and export restrictions against Iran continue to generate controversy in the United States.

Six major world powers, the European Union and the United Nations Security Council have agreed to steps that would begin to remove Iranian sanctions in exchange for limits on nuclear development.

Resistance to the agreement, especially by Republicans in the U.S. Congress, could lead to slower implementation of the plan and even secondary sanctions or restrictions, creating a more difficult path for Iran.

FOR: The USA

Any argument for falling world oil prices from increased Iranian production has to acknowledge the changed role of the United States.

The United States no longer acts as a consumption buffer for increased world oil production, with its past appetite for oil imports. An astounding increase in energy production in North America has made some American producers eager to export crude.

That’s a game-changer in the world’s ability to absorb excess oil production, especially if China’s growth slows, economic problems in Europe persist and the U.S. recovery continues at a modest pace.

Bottom Line

The short-term future of oil might not be the question.

If current production estimates are correct – never a certainty with Iran – an increase of 500,000 b/d would only take Iran back to fairly recent production levels.

A bigger question is whether the country can lift production to four million-plus b/d and then, over the longer term, move toward sustainably producing five million b/d or more in total crude and liquids.

Given the age of most existing major Iranian fields, that could require something that’s been scarce in Iran in recent years: